Is Zscaler stock worth buying?

Scaler‘S (NASDAQ: ZS) The stock fell 19% on Sept. 4 after it released its latest earnings report. In the fourth quarter of fiscal 2024, which ended July 31, the cybersecurity company’s revenue rose 30% year over year to $593 million and beat analyst expectations by $25 million. Adjusted earnings per share (EPS) rose 38% to $0.88 and beat the consensus forecast by $0.19.

These headlines seemed sound, but their outlook failed to impress bulls. Let’s see if this unpopular hypergrowth stock is still worth buying after falling almost 30% this year.

Image source: Getty Images.

Zscaler’s hypergrowth days are coming to an end

Zscaler is building “zero trust” services that treat everyone, including the C-suite, as a potential threat. It delivers its tools exclusively as cloud-native services that don’t require any on-premises devices. This lightweight approach is typically cheaper, more stable, and easier to scale than device-based services as organizations grow.

Zscaler went public in 2018. Revenue grew at a compound annual rate of 48% from fiscal 2019 through fiscal 2024, driven by rapid expansion in the zero trust and cloud-native cybersecurity markets. But growth in compute billings and total revenue has cooled over the past year.

Data Source: Zscaler. YOY = Year Over Year.

Zscaler’s revenue grew 34% in fiscal 2024, but the company expects it to grow only 20% to 21% in fiscal 2025. That would be the slowest annual revenue growth rate since its initial public offering (IPO). The company attributed the slowdown largely to macroeconomic headwinds that are causing more companies to reassess their software spending.

But it could also face stronger competition from larger and more diverse cybersecurity firms such as CrowdStrike (NASDAQ: CRWD) AND Palo Alto Networks (NASDAQ: PANW)that integrate similar zero trust tools into their endpoint security platforms. Analysts expect Zscaler revenue to grow at a compound annual rate of 21% from fiscal 2024 to fiscal 2026.

Increases spending as economic growth slows

Zscaler has remained unprofitable under generally accepted accounting principles (GAAP) since its IPO. However, in fiscal 2024, its non-GAAP operating margin increased 5 percentage points to 20% as its non-GAAP earnings per share increased 78%.

However, it expects its non-GAAP EPS to decline 10% to 12% in fiscal 2025 as it expands its sales and marketing teams to acquire new customers. Analysts had previously predicted growth of 4%.

The larger-than-expected decline worried bulls because it coincided with a slowdown in revenue growth and suggested that it was losing pricing power. It also means that Zscaler is saturating its zero-trust niche and may need to aggressively build out its ecosystem with additional cybersecurity services to continue to grow. But doing so could crush its margins, putting the company at odds with larger firms like CrowdStrike and Palo Alto.

Pay attention to his debt and dilution

Zscaler had a high debt-to-equity ratio of 2.7 at the end of fiscal 2024. This is roughly three times higher than its debt-to-equity ratio of 0.9 at the end of fiscal 2018. It has also increased its share count by 24% over the past six years.

Even after its latest earnings drop, Zscaler doesn’t look cheap at 57 times this year’s adjusted earnings. CrowdStrike, which has continued to grow faster even after suffering a catastrophic IT outage in July, is trading at 70 times forward earnings. Palo Alto, which is growing slower than both companies, has a lower forward earnings multiple of 54. Unlike Zscaler, both CrowdStrike and Palo Alto are clearly profitable by GAAP measures.

Is this a good time to buy Zscaler?

Cooling revenue growth, rising costs, high leverage, ongoing dilution, and a premium valuation make Zscaler stock hard to recommend. Insiders also sold more than 6 times as many shares as they bought in the past 12 months.

Zscaler continues to grow, but will face tougher macro and competitive challenges over the next few years. As such, I wouldn’t touch the stock until earnings growth stabilizes and valuations cool to more sustainable levels.

Is it worth investing $1000 in Zscaler now?

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Leo Sun has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends CrowdStrike, Palo Alto Networks, and Zscaler. The Motley Fool has a disclosure policy.